Brown at the edges

The chancellor has delivered stability but is now under-playing the risks to growth

BEFORE Labour regained power in 1997, Gordon Brown made two solemn pledges. There would be no return to “tax-and-spend” and there would be an end to “boom-and-bust”. The chancellor has broken the first of these promises. Households and businesses are being hit this financial year by an £8 billion ($12.5 billion) hike in national-insurance contributions. That makes it all the more vital for Mr Brown to honour his other commitment, about “boom-and-bust”. It was the combination of big tax rises with an economic bust and a collapse in the housing market that helped to destroy the Conservative government in the 1990s.

Businessmen and consumers alike have the jitters because of the war, but the economic effect of these is likely to be short. The economy has shown a remarkable stability over the past six years despite two big shocks to confidence. It kept growing when Russia's debt default in August 1998 raised fears of a big downturn. Even more impressively, it has chuntered on through the global slowdown of the last two years.

For once, Britain has proved more resilient to setbacks than other countries. In 2001 the economy grew by 2.1%, the fastest in the G7 group of advanced countries, and only a little lower than its historic growth rate of about 2.5% a year. Last year it grew by 1.8%, the third fastest among the G7.

It would be silly to praise Mr Brown alone for this. But it would be just as silly not to give credit where it is due. His bold decision to make the Bank of England independent has helped keep both inflation at bay and growth at an even tempo. The government's fiscal policy has supported demand in a downturn, whereas countries like Portugal and Germany have had to tighten policy to meet the boa constrictor rules of the euro area's misnamed Stability and Growth Pact.

But Mr Brown is now too optimistic about the outlook for growth. In his most recent economic forecast, in November, he said that the economy would pick up speed again after two years of below-trend growth, with 2.5-3% this year and 3-3.5% in 2004. In next week's budget, he will have to lower these forecasts to retain credibility. The Economist's panel of economic forecasters is expecting the economy to grow by 1.9% in 2003 and by 2.5% in 2004.

One reason is that the world economic recovery has recently faltered. The setback has been especially severe in the euro area, which accounts for around half Britain's trade. Another problem is fading hopes of a big recovery in business investment after its sharp fall of 8% last year. Thirdly, Britain's long-running consumer boom is due to run out of steam as households scrimp to meet the delayed tax rises announced by Mr Brown last year.

The chancellor could live with a failure to meet an optimistic growth forecast. He will be more hard-pressed if the economy hits real trouble. The risk lies, literally, on the home front. Along with the big boost to government spending, which increased last year at its fastest rate since 1975, the housing-market boom has been crucial in sustaining the economy. Property prices rose by about 25% in 2002 alone. Households have extracted some of this extra wealth by borrowing more in mortgages than they invested in housing.This in turn has bolstered consumer spending, which rose last year by almost 4% in real terms.

Mr Brown's nightmare is that a collapse in house prices removes this prop to consumer spending. The housing market is weakening in London, but has remained more robust in the rest of the country. According to an index compiled by the Halifax, the country's largest mortgage lender, national house prices rose by 1.1% in March and were 23.4% higher than a year ago.

But even if the whole housing market does come down with a jolt, this is unlikely to prove the catastrophe it was at the end of the 1980s. Then, interest rates rose steeply in order to slow down the economy, which had over-heated, causing a resurgence in inflation. Because the economic fundamentals are much sounder today, it seems unlikely that a housing-market bust can singlehandedly bring down the economy. Inflation is under control and employment remains high. If necessary, interest rates can fall still further, for even their current 48-year low of 3.75% is much higher than rates in America, say.

But longer-term prospects too are bleaker than Mr Brown had hoped. Last year, he raised his estimate of potential annual growth in the coming years to 2.75%. This looked unrealistic at the time and looks even more so following the sharp fall in business investment. Businessmen are now complaining that taxation and regulations are hurting the economy more and more (see article).

Slower than expected growth will mean that big budget deficits will persist. With low levels of public debt, the chancellor can easily afford to borrow, but he cannot rely on an economic bounce-back to cut the deficits. That makes another tax-raising budget only a matter of time. Mr Brown was feted for his last one, but he will get a dusty reception when he comes back for more.